November 28, 2003

Just Odd- Money Supply Falling

There's a quiet murmur on the edges of the economic profession that the US money supply has been shrinking since mid-September.

Money is the weirdest part of the economy-- I highly recommend William Greider's Secrets of the Temple for all the historical weirdness in policy debates over it.

But it's almost always considered a bad sign to see the money supply dropping, usually signalling problems in the economy.

I don't know what to make of it exactly, but try this analysis for some thoughts:

So what's to account for why the money supply falling at a time when the Fed has pushed short-term interest rates down to 45-year lows and maintains loud and clear that it is pursuing an accommodative monetary policy?

The first thing that comes to mind is that the Fed doesn't have total control over the money supply, so its decline may be a reflection, rather than a cause, of a weakening in economic activity.

Keep in mind that in our dynamic, free-market economy, the Fed can influence the supply of money, or its price (interest rates). It can't do both at the same time, however.

In recent years, the Fed has clearly chosen to manipulate the price of money. Witness its emphasis on the federal funds rate, assuming that the money supply will respond accordingly.

Essentially-- what this would mean is that Bush has been artificially pumping up the economy with deficits and the Fed has been pumping it up with low interest rates, but the money supply is signalling that beneath the surface, the patient is still very sick.

As I said, money is just too mysterious to make too much of, but here's the disturbing last sentence from the article of what this all could mean:

So could this be another liquidity trap, such as the Fed encountered in the 1930s?